May 2021 Market Commentary

May was a modest extension of the positive pattern that has been in place most of this year. Gains were delivered but not at or with the same magnitude or continuity that characterized performance through much of 2020 and into Q1 2021. Tech remained under pressure during the month but broader indexes such as the DJTMI posted several new all-time highs, including May’s final trading day. Domestic Value indexes still lead all YTD performers. 

In April, International and Emerging Markets stocks began to show strength relative to US companies. They also posted some of May’s best results. Major non-US indexes have now drawn level with US measures for the quarter and have made up a good portion of their YTD deficit with the exception of Emerging Markets. Developing countries remain laggards in vaccination rates and re-openings. Key benchmark performance for the periods noted are below. 

Bond prices remained stable despite several torrid selloffs after April inflation gauges reported substantial increases. The weakness proved short-lived however, and at month end 10 and 30-year US Treasury bond yields were moderately below April’s close. 

Observers have been perplexed by the lack of equity/bond market response to increased inflation. April upticks in producer and consumer prices plus the year-long surge in raw materials prices are prompting pundits to breathlessly predict an inflationary spiral unless the Fed tightens immediately. Meanwhile, bond markets figuratively yawn.

The Federal Reserve’s characterization of recent inflation as “transitory” is likely correct and the Fed’s Board of Governors has given no indication that policy changes are in the wind. We expect the monthly $120 billion bond purchase status quo to continue. Credit markets are happy, but we cannot yet know if intractable inflation will be the result of unchecked dollar creation.

The only hint of policy modification is the Fed’s announced intent to liquidate its modest portfolio of corporate bonds and ETFs ($13.7 billion) by year end.¹ Corporate earnings are strong and the spread (difference) between Treasury and high grade private sector yields is near historic lows. Investors quickly snap up new debt issues as corporate treasurers take aggressive advantage of historically low interest rates. This corner of the bond market is quite healthy.

So, why is the Fed still buying $120 billion of bonds every month?

In a recent interview, NY Federal Reserve Bank President, Mr. John Williams suggested that the economy needs to make “more progress” before the Fed begins to taper (reduce) its main bond purchase program.² The implication is that money printing is not close to ending, deficits be damned.

Modern Monetary Theory (MMT) is increasingly referenced by implication in the Biden Administration’s economic policies. MMT hypothesizes that economic growth rates and budget deficits do not matter and that governments can facilitate a viable economy simply by creating money and taxing high earners. Newly issued currency and tax receipts fund subsidies, tax credits, government support programs, and transfer payments to constituents.³ What could go wrong?

The President’s $6.2 trillion budget proposal attempts a practical application of MMT. The budget’s thesis is that tax credits, subsidies, and benefit outlays by the government are preferable to a growing economy as the primary source of economic well‐being for its citizens, and that MMT can be implemented without creating systemic inflation.⁴

Is this a new economic philosophy? If not, has it been tried previously? What were the results?

MMT expands the contentions of John Maynard Keynes, first published during the 1930’s Great Depression. Mr. Keynes believed that when economies contract, governments should temporarily increase spending to kickstart re‐expansion, regardless of short‐term budget shortfalls. Under MMT, this approach becomes permanent policy. Mr. Biden’s budget signals concurrence.

Annual GDP growth in the budget’s 10‐year outlook is forecasted to remain slightly above or below 2%. In inflation adjusted terms, defense spending will decline from current levels as will funding for the Dept. of Homeland Security. Direct and/or support payments, climate change initiatives, green energy conversions, electric vehicle subsidies, education, and healthcare are areas which show greatest expansion.⁵

During the Great Depression (1929‐1939) and post the 2007‐2009 recession, growth rates were stubbornly tepid despite (because of?) massive government spending. If the President’s tax and spending plans survive Congress, we expect GDP growth to stagnate. In fact, the budget predicts this outcome.⁶ GDP projections in the document are tacit confirmation that proposed taxes will constrain growth.

Critical assumptions in the budget blueprint include interest rates at or near current levels through 2031 and Covid‐19 related “emergency spending” becoming part of the budget baseline, i.e., not eliminated. One curious provision is that the Fed should use monetary policy to mitigate climate change.⁷

Spending baselines will be determined by Congress, but interest rates pinned well below the long term inflation rate for 10 years and transforming the Fed into an agent resisting climate change seem questionable.

Fed Chairman Powell was quick to repudiate climate change “directives” and imply open market bond purchases will not be indefinite. Pushback from the independent Fed against progressive initiatives that have nothing to do with growing the economy is clear.⁸

Without full cooperation from the Fed, Federal debt will become unsupportable if unrestrained spending continues. Even if current rates remain unchanged, by 2031, the budget projects annual debt interest payments alone to top $900 billion.⁹

Investors have experienced slow growth and prospered, most recently during the Obama recovery. But it is far from certain that voters pulling the lever for Mr. Biden last year envisioned a permanent change in the definition of national economic success and are, simultaneously, eagerly anticipating 10 years of swelling government, rising taxes, a depreciating dollar, and lackluster economic growth.

It is impossible to foresee at this point, how much of Mr. Biden’s FY 2022 “wish list” will be implemented. Markets remain remarkably sanguine despite the possibility of significant tax increases just over the horizon, based primarily in our view, on the Fed’s ongoing commitment to fund near term budget shortfalls and on potential resistance from moderate Senate Democrats that could torpedo the budget.

Mr. Powell and his colleagues will eventually determine the economy can survive on its own and begin to reduce support for prolific Federal spending. That point appears to be 2023, which argues for bond market stability and further equity gains in 2021.

Once tax and spending specifics are settled, however, the market’s posture could change rapidly. Americans are being asked to abandon a rapidly expanding economy in exchange for stagnation and government expansion, all in the name of equality of outcome replacing equality of opportunity as a national goal.

¹ “Fed to Sell Corporate Bonds and ETFs Acquired During Covid‐19 Crisis,” www.wsj.com, June 2, 2021. ² “NY Fed's John Williams: US economy 'quite a ways off' from tapering asset purchases,” www.finance.yahoo.com, June 3, 2021. ³ Ibid. ⁴ “What Is Modern Monetary Theory (MMT)?” www.money.usnews.com, January 8, 2021. ⁵ “What’s in Biden’s $6 Trillion Budget Plan,” www.wsj.com, May 28, 2021. ⁶ “A Future of Secular Stagnation,” www.wsj.com, June 1, 2021. ⁷ Ibid. ⁸ “Powell says Fed does not seek to set climate policy for U.S.,” www.nasdaq.com, June 4, 2021. ⁹ “Additional Information About the Budget Outlook: 2021 to 2031,” www.cbo.gov.

This commentary is provided for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. Content has been obtained from third-party sources and is believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. The views expressed in this commentary are subject to change based on market and other conditions. The commentary may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.